US stocks slide on concerns about Dubai debt fallout

Agencies|

Nov 28, 2009, 04.58 AM IST

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NEW YORK – This was the sideswipe investors had feared.

The stock market is in the middle of one of the great rallies of a generation, but for weeks there has been a nagging fear that bad news was never far off. The news came from Dubai, a wealthy Middle Eastern city-state that many Americans probably couldn't find on a map. Concerns that a government-backed investment company risked defaulting on $60 billion in debt ripped through world markets and served as a reminder of how fragile the financial system remains a year after it nearly collapsed.

The Dow Jones industrial average slumped 155 points on Friday before trading ended three hours early due to the Thanksgiving holiday. The Dow fell as much as 233 points. The broad retreat from riskier assets pushed Treasury prices higher. The dollar gained against most other major currencies and commodities tumbled.

Now the question that will dog investors over the weekend is whether the markets will shrug off a financial crisis in the Middle East or seek protection in more conservative investments. That could end a rally that has seen the Dow surge 57.5 per cent since March 9.

Stocks ended well off their lows but analysts cautioned that the shortened day and scarcity of traders meant the real test for the markets will come next week as traders return from long weekends.

The day's gyrations made clear that investors who might have been buying up stock in the past eight months remain on edge about faults in the financial system and the economy.

Worries about bad debt are fresh in investors' minds after the collapse of the US brokerage Lehman Brothers in September last year kicked the US economy deeper into recession overnight as banks halted lending on fears about the extent of bad loans.

The latest concern is that problems in Dubai, which has drawn wealthy tourists and investors from around the globe in the past decade with its Las Vegas-in-the-Middle East appeal, could imperil a nascent economic rebound around the world. This could happen if banks suffer big losses or confidence falters.

"The biggest risk is a domino effect," said Kevin Shacknofsky, portfolio manager of the Alpine Dynamic Dividend Fund in Purchase, NY.

The latest trouble on Wall Street comes as the US kicks off the unofficial start to the holiday shopping season. Investors will be tracking news from retailers for insights into how much consumers will spend in the coming month. Consumer spending is the biggest driver of the US economy.

The Dow fell 154.48, or 1.5 per cent, to 10,309.92. It was the Dow's biggest drop since Oct. 30.

The broader Standard & Poor's 500 index fell 19.14, or 1.7 per cent, to 1,091.49, and the Nasdaq composite index fell 37.61, or 1.7 per cent, to 2,138.44.

For the week, the Dow slipped 0.1 per cent, breaking a three-week winning streak. The S&P 500 index rose less than 0.1 per cent and the Nasdaq fell 0.4 per cent. Stocks are still up sharply for the month and the year.

Analysts were divided over whether Dubai's problems meant more trouble was to come.

Jeffrey Frankel, president of Stuart Frankel & Co. in New York, said US investors were given a chance to digest the news with markets closed on Thanksgiving. Reports of Dubai's problems surfaced during trading on Wednesday and drew little initial reaction.

"It was like we were in a coma for a day and awoke and the worst had passed," he said.

In the past, financial time-bombs have been hard to detect. The subprime mortgage crises that helped tip the US into recession began with small pops that grew louder as the extent of the problems with souring debt became clear.

Earlier this week, Dubai World, the city's main investment arm, said it had asked creditors for a six-month freeze in repaying the debt.

Dubai, part of the United Arab Emirates, has been better known for lavish hotels, palm-shaped islands and indoor skiing, than for financial problems brought by the recession. Whether Dubai's troubles prove to be a hiccup or something worse, investors didn't take chances.

The yield on the benchmark 10-year Treasury note, which moves opposite its price, fell to 3.21 per cent from 3.28 per cent late Wednesday. The yield on the three-month T-bill, which is considered one of the safest investments, fell to 0.01 per cent from 0.03 per cent.

The ICE Futures US dollar index, which measures the greenback against a basket of foreign currencies, rose 0.2 per cent.

Commodities, which are priced in dollars, fell as the dollar gained. The move reflected an unwinding of trades that relied on a weak dollar to finance purchases of higher-yielding assets. Spooked traders reversing the so-called "carry trade" were demanding safe-haven assets.

Investors have been pushing into riskier assets in recent months as they seek bigger gains. US interest rates are at record lows, making riskier investments like stocks an enticing alternative to the paltry returns of safer investments.

Crude oil fell $1.91 to settle at $76.05 per barrel on the New York Mercantile Exchange after being down by more than $5. Gold fell after a 10-day climb.

European markets, which fell more than 3 per cent Thursday, closed higher after an early slide. Britain's FTSE 100 rose 1 per cent, Germany's DAX index rose 1.3 per cent and France's CAC-40 advanced 1.2 per cent.

Shacknofsky said the reaction and calming of currency markets and the rebound in Europe was a signal investors are taking Dubai's problems in stride.

"The currency markets and the European markets are telling us that this not as bad as initially thought," he said.

The worries about Dubai erupted amid a period of relative calm in US markets. The Chicago Board Options Exchange's Volatility Index, known as the market's fear index, rose more than 4 per cent. On Wednesday it fell to its lowest level since August 2008 after jumping to a record in October last year around the height of the financial crisis. A drop in the VIX signals investors aren't as worried about big swings in the market.

The latest test of the market still leaves major stock indicators up more than 4 per cent for the month so analysts said some selling was due. The S&P 500 index is up 61.3 per cent from a 12-year low in March.

Trading volume in November has been light as many professional investors have pulled back from markets in hopes of locking in big gains for 2009.

Dave Rovelli, managing director of trading at brokerage Canaccord Adams in New York, said investors have been too quick to assume that the financial markets are on the mend.

"We're way ahead of ourselves in this market. We're in the eye of the storm now and we've been in it since March," he said. "Now we're in the back end of the storm."

Consolidated volume on the New York Stock Exchange came to 2.3 billion shares.

The Russell 2000 index of smaller companies fell 14.98, or 2.5 per cent, to 577.21.